Nexus Perplexus

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Paging Wile E. Coyote.

For decades, executives at The Risk Management Association (badus stuffus limitus) have been doing what they’ve always done: devising and selling training materials for credit- and risk-management lending professionals. The goal of the RMA (www.rmahq.org), which has been around since 1914, is a pretty simple one. Through education and training, it strives to help corporate risk managers keep nasty surprises to a minimum.

Then, out of the blue, an anvil got dropped on the RMA. In the early 1990s, the state of New York (taxus maximus) informed officials at the not-for-profit association that the group was being audited. According to representatives at the New York Department of Tax and Finance, the Philadelphia-based RMA met the standard for nexus (a physical presence) and therefore was required to pay back sales tax on purchases made by residents of the Empire State. Earlier, the RMA’s tax adviser had come to the opposite conclusion.

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Eventually, managers at the RMA were able to negotiate a settlement with tax officials in New York. But wary of that anvil, the managers decided not to take any more chances; they hired an attorney to look at all other states with a sales tax to see if the RMA was at risk. The finding? ”Many states had fairly ambiguous laws on their books,” says Dwight Overturf, controller at the RMA. ”So rather than gamble, we decided to register with all states that have a sales tax — and to collect and remit those taxes.”

As Overturf soon found out, however, filing returns in all jurisdictions with a sales tax — 45 states, Washington, DC, and 6,000 local municipalities — can create a huge administrative burden. Just keeping up with constantly changing tax rates can tie up entire finance departments.

So, in 1999, managers at the RMA decided that they would automate the process. The group purchased Internet Sales Tax, a software package that was designed by Taxware International. The Taxware program ties into the RMA’s order entry system, providing tax rates for all relevant states, counties, and cities. Now, whenever an order is placed over the association’s Web site or by phone, the application immediately identifies where the customer resides, assesses the appropriate tax, and tacks that on to the invoice.

The Volunteer States

Not surprisingly, state authorities love programs like Internet Sales Tax, as well as other Web-enabled tax compliance software. While the 1998 Internet Tax Freedom Act did prohibit additional or discriminatory taxes being placed on ecommerce transactions, it didn’t eliminate sales tax on virtual purchases. If an online seller has nexus in a state, then that seller must assess, charge, and remit sales tax. If an etailer doesn’t meet the standard for nexus, then consumers are generally required to pony up use taxes on virtual purchases.

Fat chance. In fact, state governments, which get a third of their income from sales tax, are losing out on billions in ecommerce sales. Naturally, recouping some of that lost revenue has become a high priority for many state and local tax authorities. Thirty-eight states now support the Streamlined Sales Tax Project, a state government initiative to simplify ”sales and use tax collection for all types of commerce.”

Charles Collins, director of the sales and use tax division for the state of North Carolina, says the goal of the SSTP is to make it simpler for merchants to comply with complicated sales tax laws. By reducing the compliance burden, state tax authorities hope to encourage remote vendors to voluntarily collect and remit taxes. ”That’s important,” says Collins. ”We estimate we’ve lost about $140 million on remote purchases [in 1999-2000] where we cannot require the seller to collect the tax.”

Of course, you have to wonder why any company would pay taxes it doesn’t necessarily have to. But some local tax authorities point out that standards for nexus vary from state to state, county to county, year to year. Indeed, a press release put out by the SSTP notes that ”vendors operating in the 45 states with sales taxes must comply with multiple tax rates, varying laws on product definitions, extensive tax return requirements, and costly and time-consuming annual audits.” The not-so-subtle implication: Remote sellers are better off paying taxes now than being socked with a big assessment down the road.

Four states — Michigan, Kansas, North Carolina, and Wisconsin — recently launched an SSTP pilot program. Run in conjunction with vendors Taxware, esalestax.com, and Pitney Bowes, the pilot is half tax collection, half tax forgiveness. ”The states are offering [businesses] the option of not being held liable for what they didn’t do in the past, as long as they [assess and remit taxes] going forward,” explains Jon Abolins, vice president of tax and government affairs at Taxware. ”It’s really a revolution in tax collection.”

Carrot Dangling

Keen to get corporations to sign up for the revolution, the four states are offering a substantial enlistment bonus. Participants in the SSTP pilot not only get their sales tax calculated and reports filed for free each month, they’re also immune from future audits (except for fraud).

That could be a big selling point, particularly for corporate executives who’ve found themselves on the fuzzy end of a nexus assessment. The RMA, for one, signed up for the SSTP pilot in February. Managers set up a special bank account, and Taxware draws down on the account to remit sales tax to the four states.

Overturf believes the SSTP model will prove to be a time-saver. Right now, he says, the finance staff at the RMA spends two weeks each month preparing tax returns. If enough states support the SSTP model, he thinks it could eliminate a week’s worth of work per month. ”If this takes off,” says Overturf, ”I’m looking at a potential of 30 states that may become part of the program.”

Of course, the success of the SSTP will depend on how many taxpayers — not tax collectors — decide to participate. Privately, managers at several etailers concede that many consumers shop online because they don’t have to pay sales tax on cyber-purchases. The merchants say they’d lose customers if they levied sales tax on e-transactions.

This may explain, in part, why only three for-profit companies — Piercing Pagoda, Polycom, and O.C. Tanner — had signed up with Taxware to participate in the pilot, as of press time. The SSTP test is scheduled to run through the end of September, although the four states can extend the project for two six-month periods. Even after the pilot phase has ended, Abolins says, tax chiefs should still consider getting in on the program. The price is right, that’s for sure. Notes Abolins: ”The whole point is, the states will pay us to perform this service.”

Nice work if you can get it. According to SSTP documents, the four states have agreed to pay certified service providers 3 cents per invoice line item or 12 cents per invoice. Depending on the state, participating vendors will also collect a 5 or 6 percent fee on any new taxes collected.

Soupy Sales Tax

Given that setup, it’s easy to see why service providers might be enthusiastic about the SSTP project. Getting companies ginned up about paying taxes they don’t necessarily owe may prove slightly tougher. To date, the SSTP pilot has attracted mostly smaller businesses that sell products and services across a handful of municipalities.

O.C. Tanner is on the larger end of the scale. The Salt Lake City-based jewelry company, which is the official medal maker for the 2002 Winter Olympics, has nexus in every state. Tax manager Jake Garn points out that the retailer already uses Taxware’s system to maintain rate tables and prepare reports for filing returns. Thus, Garn says, outsourcing the whole sales tax process seemed like a logical next step.

It took some convincing to get the company to take that step, however. To help sway Tanner management, Taxware agreed to pay the jewelry maker a portion of the fees the vendor receives from the pilot’s sponsor states. (The other Taxware clients in the pilot did not negotiate any compensation, says Abolins.)

Once the virtual tax collection gets under way, finance department employees at Tanner will access a Web site hosted by Hewlett-Packard. Once on the site, the staffers will input all necessary information. Taxware applications will then calculate, collect, and remit the sales taxes on every remote purchase. ”Instead of us having to have employees do this work — at least in the four states — the whole process will be automated,” reports Garn.

While the Tanner tax chief is cautiously optimistic the SSTP approach will take off, he remains skeptical that all states will agree to adopt a single sales and use tax remittance mechanism. By his reckoning, US tax laws are simply too regionalized, too murky, to fit neatly into one overarching collection system. ”In Alabama, for example, you have several hundred locally administered cities that collect their own taxes,” he notes. ”So you have to file separate returns for those localities.” The same setup exists in Colorado, Arizona, and Louisiana.

Further, every state has different rules governing what gets taxed and what doesn’t. In some locales, snack foods are taxable while other foods are not. In several states, services are taxable. In addition, some cities — notably, New York — occasionally run no-sales-tax weekends to help support local merchants. ”There’s different audit procedures, and roles are significantly different,” asserts Garn. ”When you’re trying to have a uniform system that can be administered over the Internet, I think it can be prohibitive.”

Still, if the SSTP pilot brings in enough tax revenue from enough remote businesses — and is simple enough to use — more local authorities will sign on. Already, the National Governors Association and The National Conference of State Legislatures have thrown their considerable weight behind the project. Claims North Carolina’s Collins: ”I think there’s the potential for all states to be involved.”

It’s starting to look that way. Recently, Arkansas, Wyoming, Utah, and Kentucky passed legislation green-lighting testing of the SSTP setup. ”If all states went to this program,” Garn envisions, ”we’d point our tax information to this third-party ASP in partnership with the states. Then, we’d get out of the business of filing tax returns.”